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The U.S. Court of Appeals for the Sixth Circuit (appeals court) granted a 30-day administrative stay, temporarily relieving Eaton from complying with an IRS summons requesting annual performance evaluations for certain foreign employees as part of a transfer pricing audit (US v. Eaton Corp. No. 24-3732 (6th Cir. Sept. 3, 2024).

The U.S. Court for the Northern District of Ohio (district court) had confirmed in an earlier opinion that the IRS summons should be enforced (US v. Eaton Corp., No. 1:23-mc-00037 (N.D. Ohio, Aug. 19, 2024)). Denying Eaton's motion for reconsideration of an earlier decision, the same district court judge found that the comity factors weigh in favor of enforcing the summons, which trumps the GDPR blocking Eaton from producing the employee evaluations (see Tax Alert 2024-1136 for information on the earlier decision).

Background

The IRS is conducting a transfer pricing audit for 2017, 2018 and 2019, examining whether Eaton's sale of certain intellectual property to its Irish affiliate, Eaton Intelligent Power Limited (EIPL), was conducted on an arm's-length basis under IRC Section 482.

The IRS issued summonses under IRC Section 7602 on February 15, 2023, for employee evaluations for certain domestic employees and employees of Eaton's foreign related parties. On August 27, 2023, the IRS served a summons on Eaton with a similar request under IRC Section 6038A, which requires certain foreign-owned domestic corporations to maintain and provide the IRS with specified information on transactions and related parties.

Both the IRS and Eaton filed memorandums on the summonses on November 22, 2023, regarding whether to enforce the summons for the foreign employees' performance evaluations.

Magistrate judge's ruling

In January 2024, a magistrate judge in the district court recommended denying the IRS's summons, finding that (1) the performance evaluations of the foreign employees were not shown to be relevant to a legitimate purpose, and (2) the balance of the factors under the five-factor comity analysis¹ for determining whether to order the production of evidence located in a foreign country weighs against disclosure.

May 2024 district court ruling

In May 2024, the district court judge rejected the magistrate judge's recommendation and enforced the IRS's summons for foreign employees' performance evaluations. The district court found that (1) the IRS met its burden for enforcing the summons under the correct standard of considering what requested information "may be relevant," (2) the GDPR did not prohibit Eaton from producing the employee evaluations, and (3) even if it did, comity factors required summons enforcement.

August 2024 district court ruling

GDPR

The district court changed its earlier finding about the GDPR and found in this decision that the GDPR blocks the Irish affiliate, and therefore US Eaton, from producing the foreign employee performance evaluations.

In its analysis, the court said the GDPR would not block document production if the public interest derogation applied, which happens when the requested document production is "(1) necessary or legally required and (2) based on important public interest grounds."

In the May decision, the district court said the existence of a tax treaty between the United States and Ireland satisfied the public interest derogation. In this decision, the district court said Eaton successfully argued that that the summons was issued to US Eaton, not the Irish affiliate, and therefore the summons did not legally obligate the Irish affiliate to supply the employee evaluations. In addition, the employee evaluations were not strictly necessary because they are "only slightly relevant to transfer pricing," according to the district court.

Comity analysis

As in its earlier opinion, the district court found that comity factors favor enforcement of the summons, even if it is blocked by foreign law. In the May decision, the district court analyzed the five factors and found that the fifth one, "the extent to which noncompliance with the request would undermine important interests of the United States, or compliance with the request would undermine important interest of the state where the information is located," was the most important and weighed strongly in favor of enforcement of the IRS summons.

The district court confirmed that the fifth factor still weighed strongly in favor of enforcement because (1) the GDPR's privacy interests are not as strong because the US-Ireland tax treaty significantly mitigates the GDPR's privacy interest, (2) courts are not limited to assessing whether a GDPR derogation expressly applies, and (3) the "US-Ireland tax treaty partially satisfies the public interest derogation, so Ireland's tax cooperation interest can reduce the GDPR's privacy interest."

The district court also confirmed that the fourth factor still favors enforcement because the availability of alternative-information-gathering means did not weigh in favor of Eaton. Eaton's proposed alternative means, to have the IRS interview employees, could limit the information available to the IRS and take significantly more time and resources, the district court said.

The district court rejected Eaton's argument that it should consider a sixth factor of good faith. The district court said this was the first time that Eaton has suggested that good faith is relevant to the comity analysis, and it was too late to raise it in post-judgment proceedings. In addition, the district court said good faith is not a comity factor under the Supreme Court's ruling or the Sixth Circuit Court of Appeals. While "good faith can often mitigate the sanctions imposed for violating legal obligations, rarely does good faith justify noncompliance with legal obligations," the district court said.

Request for stay

The district court denied Eaton's request for a stay pending appeal on the grounds that (1) Eaton is not likely to succeed on appeal, (2) the irreparable harm Eaton would suffer from violating the GDPR absent a stay "is likely small" because the European authorities will probably act reasonably and proportionally, (3) a stay would injure the IRS because it would hinder the IRS's tax audit, and (4) the public interest in tax collection strongly supports denying a stay.

Appellate court ruling

The appeals court granted Eaton's request for a 30-day administrative stay, which the IRS did not contest. The appeals court said an administrative stay preserving the status quo was appropriate given that (1) compliance with the summons could violate European Union regulations and expose Eaton to liability, and (2) the government did not oppose the stay.

Implications

The district court's reaffirmation of the IRS's authority to enforce the summons highlights the complexities of navigating international privacy laws in US transfer pricing audits. Taxpayers must be prepared for the IRS's broad summons power, even when foreign laws like the GDPR are involved, and should consider the potential legal and practical implications of such cross-border conflicts in their documentation and compliance strategies. The decision also indicates that courts may prioritize US tax enforcement over foreign privacy concerns, particularly when international tax treaties provide some level of cooperation or public interest derogation.

Taxpayers should consider appropriate steps to make sure their IRC Section 6662 transfer pricing documentation is adequate and reasonable, as well as be prepared for extensive information document requests around significant material intercompany transactions. Recent IRS audit trends in the area of transfer pricing have shown that the IRS is asking for more extensive information and documentation than what is requested in a routine international audit.